Marginal Analysis

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Definition of Marginal Analysis:

Marginal analysis is the study of the incremental or next unit. For example a producer's marginal cost is the added cost to produce one more unit of a good or service. A person's marginal propensity to consume is the amount a consumer will spend of the next dollar received. 

Detailed Explanation:

What is the benefit of purchasing another item? What is the cost to produce one more item? These are decisions made at the margin. Analyzing these decisions is marginal analysis. Economists frequently use marginal analysis when evaluating economic decisions and policy. When reaching a decision, it is important consider only the costs and benefits derived directly or indirectly from the immediate decision. Consumers purchase an item only if the benefit gained from the unit they are purchase is equal or exceeds the cost of purchasing that unit. For example, you may decline buying dessert after a great meal because the cost is just not worth it. The benefit gained is less than the cost.

Marginal analysis also provides insight on how producers reach decisions. For example, it explains why consumers can sometimes get a great deal if they wait until the last minute to take a cruise. Assume the added cost of a passenger is $150. This includes only costs directly attributable to the added passenger such as food and drink. Costs including fuel, wait staff, or stewards would not be included since they would be unchanged if another passenger is added at the last minute  Assume the cruise line is able to sell an additional last-minute ticket for $200. The line would be $50 better off than if they had departed without the passenger. Here, the marginal cost is $150, and the marginal revenue is $200. The cruise line would not sell a ticket for $125 because $125 would not cover the $150 cost directly associated with the added passenger. The bottom line is that vacant airline seats, cruise cabins, or hotel rooms do not generate any revenue. Companies may be willing to offer large last-minute discounts if they are able to sell those items at an amount exceeding their marginal cost, or the added cost of that additional customer. 

Dig Deeper With These Free Lessons:

Marginal Analysis - How Decisions Are Made
Supply - The Producer's Perspective
Fiscal Policy - Managing an Economy by Taxing and Spending
Fundamental Economic Assumptions
Market Structures Part I - Perfect Competition and Monopoly
Output and Profit Maximization

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